Solution manual for International Trade 4th

Edition Feenstra Taylor 1319061737

9781319061739
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4 Trade and Resources: The Heckscher–Ohlin Model

1. In this problem you will learn how to download data for U.S. export and imports for
highly disaggregated products. Supposes that you are hired by a company that wants
to start exporting the product it already sells in the United States. You are asked to
find out how much is already sold abroad by other U.S. firms and to which countries.
To answer this question, you can access the “Trade Stats Express” database at the
International Trade Administration, U.S. Department of Commerce.

U.S. Exports and Imports for 2014

Region or Export Import

HS Code Product
Country ($ thousands) ($ thousands)
Coffee, Tea, Mate,
09 Africa 3,666 356,399
and Spices
0901 Coffee Africa 209 225,090
0902 Tea Africa 291 34,781
0904 Pepper Africa 1,794 0
0905 Vanilla Beans Africa 0 74,809
Ginger, Saffron,
0910 Turmeric, Thyme, Africa 1,235 9,359
Bay Leaves, etc.
Coffee, Tea, Mate,
09 Kenya 12 52,966
and Spices
0901 Coffee Kenya 12 43,692
0902 Tea Kenya 0 9,260
0904 Pepper Kenya 0 0
0905 Vanilla Beans Kenya 0 0
Ginger, Saffron,
0910
Turmeric, Thyme, Kenya 0 14
Bay Leaves, etc.

a. Start at the webpage http://www.trade.gov/, and find Trade Stats Express under the
Data & Analysis tab. Choose National Trade Data, and Product Profiles of U.S.
Merchandise Trade with a Selected Market. You will be asked to select a Region
or Trade Partner, to select Export, Imports, or Trade Balance, and then to select a
Product. The method of keeping track of products is called the Harmonized
System (HS). On this page, the HS codes for products can have 2 digits or 4
digits, so choose 4 digits. Change the product from HS-total to any particular
product that you find interesting out of the 99 HS codes that are shown, from HS
01 to HS 99. For the product that you have selected, choose a region of the world,
and write down in a table the exports to that region of the 2-digit and detailed 4-
digit products that are shown (see an example for HS 09 in the table).

Answer: The argument depends on the chosen countries and the trade pattern
within the United States. The below argument is an example based on the table
provided.
 Because the United States is relatively abundant in skilled labor and scarce in
unskilled labor, as predicted by the Heckscher–Ohlin model, the United States
imports unskilled-labor-intensive goods such as the ones listed in the table. One
exception is pepper, whose production may depend on machines that are abundant
in the United States.

b. Repeat the same exercise for the imports to the United States from that region for
the 2-digit and detailed 4-digit products that are shown (see table on the previous
page).
Answer: Answers will vary.
c. Now choose at least one specific country in the region that you have chosen, and
write down the U.S. exports and imports for the same 2-digit and 4-digit HS
products (see table on the previous page).
Answer: Answers will vary.
d. Do you think that the U.S. exports and imports for this region/country/products
you have chosen support the predictions of the Heckscher–Ohlin theorem?
Explain why or why not. Do you think that there is potential for the U.S. firm that
hired you to begin exporting these products? Explain.
Answer: Answers will vary.

2. This problem uses the Heckscher–Ohlin model to predict the direction of trade.
Consider the production of handmade rugs and assembly line robots in Canada and
India.

a. Which country would you expect to be relatively labor-abundant, and which is

capital-abundant? Why?
Answer: Given Canada’s relatively small population (approximately 30 million
compared with more than 1 billion in India) and level of development, it is a safe
assumption that 𝐿𝐿𝐶𝐶𝐶𝐶𝐶�� ⁄𝐾��𝐶𝐶𝐶𝐶𝐶𝐶 <
𝐿𝐿𝐼��𝐶��𝐼�� ⁄𝐾��𝐼��𝐶��𝐼�� . That is, there is more capital per worker in
Canada, making it capital-abundant compared with India. Similarly, India would
be labor-abundant.

b. Which industry would you expect to be relatively labor-intensive, and which is

capital-intensive? Why?
Answer: Given the amount of capital required to produce robots and the amount
of labor required to produce rugs, one would expect that
𝐿𝐿𝑅��𝑅��𝑅𝑅𝑅��𝑅�� ⁄𝐾��𝑅��𝑅��𝑅𝑅𝑅𝑅𝑅�� < 𝐿𝐿𝑅��𝑅𝑅𝑅��
⁄𝐾��𝑅��𝑅𝑅𝑅�� , making robots capital intensive and rugs labor intensive.

c. Given your answers to (a) and (b), draw production possibilities frontiers for each
country. Assuming that consumer preferences are the same in both countries, add
indifference curves and relative price lines (without trade) to your PPF graphs.
What do the slopes of the price lines tell you about the direction of trade?
 Canada’s no-trade production and consumption of robots and rugs corresponds to
a relative price of robots that is lower than that in India. This is shown by the
flatter-sloped relative price line in Canada.

d. Allowing for trade between countries, redraw the graphs and include a “trade
triangle” for each country. Identify and label the vertical and horizontal sides of
the triangles as either imports or exports.
Answer: See the following figures.

e. Using the PPF graphs from (c) and relative prices under autarky and trade, explain
how both countries gain from trade?
Answer: See figures below. The dashed lines represent the budget line and obtained
utility under autarky, while solid lines are for free trade. Under free trade, both
countries reach the indifference curve with higher utility.
3. Leontief’s paradox is an example of testing a trade model using actual data
observations. If Leontief had observed that the amount of labor needed per $1 million
of U.S. exports was 100 person-years instead of 182, would he have reached the same
conclusion? Explain.
Answer: If the amount of labor required for $1 million of U.S. exports were 100
person-years instead of 182, then the capital/labor ratio for exports would have been
$25,500 per person. Because this is larger than the corresponding ratio for imports,
this test would have provided support for the Heckscher–Ohlin theorem. That is, the
United States (which was assumed to be capital-abundant in both cases) would have
been shown to export capital-intensive goods. In actuality, however, Leontief’s test
showed exactly the opposite.

Work It Out

Suppose that there are drastic technological improvements in shoe production in

Home such that shoe factories can operate almost completely with computer-aided
machines. Consider the following data for the Home country:

Computers: Sales revenue = 𝑃𝑃𝑐�� 𝑄��𝑐𝑐 = 100

Payments to labor = 𝑊𝑊𝐿𝐿𝑐𝑐 = 50
Payments to capital = 𝑅��𝐾��𝑐𝑐 = 50
Percentage increase in the price = ∆𝑃𝑃𝑐�� ⁄𝑃𝑃𝑐𝑐 = 0%
Shoes: Sales revenue = 𝑃𝑃𝑠�� 𝑄��𝑠𝑠 = 100
Payments to labor = 𝑊𝑊𝐿𝐿𝑠𝑠 = 10
Payments to capital = 𝑅��𝐾��𝑠𝑠 = 90
Percentage increase in the price = ∆𝑃𝑃𝑠�� ⁄𝑃𝑃𝑠𝑠 = 40%

a. Which industry is capital-intensive? Is this a reasonable question, given that some

industries are capital-intensive in some countries and labor-intensive in others?
Answer: 𝑊𝑊𝐿𝐿𝑐�� ⁄𝑅��𝐾��𝑐𝑐 > 𝑊𝑊𝐿𝐿𝑠�� ⁄𝑅��𝐾��𝑠𝑠 (and thus
𝐿𝐿𝑐�� ⁄𝐾��𝑐𝑐 > 𝐿𝐿𝑠�� ⁄𝐾��𝑠�� ) implies that shoes
are capital-intensive. This is certainly possible as shown in the New Balance
 application. In reality, shoes are labor-intensive in India with different production
technology. This is factor intensity reversal.

b. Given the percentage changes in output prices in the data provided, calculate the
percentage change in the rental on capital.
Answer:
For computers: = [(∆𝑃𝑃𝑐�� ⁄𝑃𝑃𝑐�� )𝑃𝑃𝑐�� 𝑄��𝑐𝑐 −
∆𝑅��⁄𝑅𝑅 (∆𝑊��⁄𝑊�� )𝑊𝑊𝐿𝐿𝑐�� ]⁄𝑅��𝐾��𝑐𝑐
= [(0%)(100) − (∆𝑊��⁄𝑊��)(50)]⁄50
= −(∆𝑊��⁄𝑊��)
For shoes: = [(∆𝑃𝑃𝑠�� ⁄𝑃𝑃𝑠�� )𝑃𝑃𝑠�� 𝑄��𝑠𝑠 −
∆𝑅��⁄𝑅𝑅 (∆𝑊��⁄𝑊�� )𝑊𝑊𝐿𝐿𝑠�� ]⁄𝑅��𝐾��𝑠𝑠
= [(40%)(100) − (∆𝑊��⁄𝑊��)(10)]⁄90
= 40⁄90 − (∆𝑊��⁄𝑊��)(10⁄90)

Substituting the computer equation into the shoes equation:

∆𝑅��⁄𝑅𝑅 = 40⁄90 + (∆𝑅��⁄𝑅��)(10⁄90)

This implies: ∆𝑊��⁄𝑊𝑊 = − ∆𝑅��⁄𝑅𝑅 = −50%

c. How does the magnitude of this change compare with that of labor?
Answer: As seen in the percentage change calculation for the rental of capital in
the shoe industry, the magnitudes of the changes are equal (with opposite sign).

d. Which factor gains in real terms, and which factor loses? Are these results
consistent with the Stolper–Samuelson theorem?
Answer: Because the increase in capital returns (+50%) exceeds the price
changes in both industries, capital gains in real terms. Similarly, because there is a
decrease in wage (−50%) and the prices of the outputs stayed the same for
computers or increased for shoes, labor loses in real terms. This is consistent with
the Stolper–Samuelson theorem: In the long run, when all factors are mobile, an
increase in the relative price of a good will cause the real earnings of labor and
capital to move in opposite directions, with a rise in the real earnings of the factor
used intensively in the industry whose relative price went up and a decrease in the
real earnings of the other factor.

4. Using the information in the chapter, suppose Home doubles in size, while Foreign
remains the same size. Show that an equal proportional increase in capital and labor
in Home will change the relative price of computers, wage, rental on capital, and the
amount traded but not the pattern of trade.
Answer: An equal proportional increase in Home’s capital and labor does not change
its relative factor endowments, so the labor/capital ratio is unchanged. With constant
factor prices, your graph should show that the no-trade equilibrium doubles. Further,
the no-trade equilibrium in Foreign is unaffected because its size remained
unchanged. At the original world relative price of computers, the quantity exported by
Home exceeds the quantity Foreign wants to import, leading to a drop in the relative
price. The lower free-trade relative price of computers decreases the rental on capital.
However, labor is better off in real terms as a result of the decrease in the relative
price of computers from free trade. The pattern of trade remains the same, although
 the amount traded has increased. The pattern of trade is consistent with the
Heckscher–Ohlin theorem. Despite the proportional increase in its endowments,
Home is still capital-abundant, and it continues to export capital-intensive goods.

5. Using a diagram similar to Figure 4-12, show the effect of a decrease in the relative
price of computers in Foreign. What happens to the wage relative to the rental? Is
there an increase in the labor–capital ratio in each industry? Explain.
Answer: With free trade the labor-abundant Foreign country will increase production
of the labor-intensive good (shoes), leading to a rightward shift of the relative demand
curve from 𝑅𝑅𝑅𝑅 ∗ ∗ ∗
1 to 𝑅𝑅𝑅��2 . At the new equilibrium point 𝐵𝐵 , computers are
weighted
∗
less, a fall in (𝐾𝐾𝑐
⁄𝐾𝐾∗ ), whereas the shoe industry is weighted more, a rise in
∗ ∗ 𝑐
(𝐾𝐾𝑠�� ⁄𝐾𝐾 ). As a result of the rise in the relative demand for labor in the shoe
industry, the
relative wage increases, which in turn lowers the labor/capital ratio in both industries.
6. Suppose when Japan opens to trade, it imports rice, a labor-intensive good.

a. According to the Heckscher–Ohlin theorem, is Japan capital-abundant or labor-

abundant? Briefly explain.
Answer: Japan is capital-abundant because it imports the labor-intensive good.

b. What is the impact of opening trade on the real wage in Japan?

Answer: Japan will specialize in the capital-intensive product, which will lead to
an increase in the relative demand for capital in the capital-intensive industry.
This causes an increase in the relative rent. The higher relative rent cuts the
number of capital hired per unit of labor in the capital-intensive industry, thereby
decreasing the capital/labor ratio. By the law of diminishing returns, the decrease
in the capital/labor ratio leads to an increase in the marginal product of capital in
both industries. Thus, the real rent will increase in Japan following trade.

c. What is the impact of opening trade on the real rental on capital?

Answer: The real rental on capital will increase because the world relative price of
rice is lower than Japan’s no-trade relative price. More specifically, the marginal
product of capital increases, so the real rental on capital rises. Based on the Stolper–
Samuelson theorem, the abundant factor gains from trade, whereas the scarce
factor loses from trade. Japan is labor-scarce and imports labor-intensive goods, so
the real rental on capital increases as a result of trade.

d. Which group (capital owner or labor) would support policies to limit free trade?
Briefly explain.
Answer: The labor group will support policies to limit free trade because they
 suffer a loss due to the decrease in the relative price of rice when Japan engages in
trade.

7. In Figure 4-3, we show how the movement from the no-trade equilibrium point A to a
trade equilibrium at a higher relative price of computers leads to an upward-sloping
export supply, from points A to D in panel (b).

a. Suppose that the relative price of computers continues to rise in panel (a), and
label the production and consumption points at several higher prices.
Answer: See the following figure.

b. In panel (b), extend the export supply curve to show the quantity of exports at the
higher relative prices of computers.
Answer: Refer to the following diagram. At the no-trade price of
(𝑃𝑃𝑐�� ⁄𝑃𝑃𝑠�� ) 𝐶𝐶 = 0.5, Home exports 0 units of computers, which is the
starting point for the Home export supply curve in panel (b). As the world relative
price of computers rises,
the exports of computers initially must rise on the export supply curve, as
illustrated by Home’s exports of 10 units when the world price is
(𝑃𝑃𝑐�� ⁄𝑃𝑃𝑠�� )𝑊��1 = 1, with production at B1 and consumption at C1. But for
higher prices, it is possible that the export supply curve bends backward, as
illustrated by the world price of (𝑃𝑃𝑐�� ⁄𝑃𝑃𝑠�� )𝑊��2 = 1.5, where the export
supply is less than 10 units, with production at B2 and consumption at C2. At these
points, consumption of computers is 30 units and production is below 40 units,
say 39 units, so exports are 9 units. Ultimately, at the corner solution, the world
relative price of computers will be completely vertical, meaning the 𝑃𝑃𝑐�� ⁄𝑃𝑃𝑠𝑠 =
infinity.
 c. What happens to the export supply curve when the price of computers is high
enough? Can you explain why this happens? Hint: An increase in the relative
price of a country’s export good means that the country is richer because its terms
of trade have improved. Explain how that can lead to fewer exports as their price
rises.
Answer: As the world-relative price for computers rises, this is a terms-of-trade
gain for the Home country, which exports computers. From the point of view of
Home consumers, it is like a rise in income, so they consume more of both
computers and shoes (the income effect). On the other hand, the rise in the
relative price of computers leads them to substitute away from this good (the
substitution effect). When the income effect dominates the substitution effect, as
will occur for sufficiently high increases in the terms of trade, then exports of
computers will fall due to increased Home demand.

8. On March 2, 2013, Tajikistan successfully negotiated terms to become a member of

the World Trade Organization. Consequently, countries such as those in western
Europe are shifting toward free trade with Tajikistan. What does the Stolper–
Samuelson theorem predict about the impact of the shift on the real wage of low-
skilled labor in western Europe? In Tajikistan?
Answer: According to the Stolper–Samuelson theorem, the real wage of unskilled
labor in western Europe will experience a decrease in real earnings because western
Europe is skilled-abundant relative to Tajikistan and will specialize in the skilled-
intensive good. By trading with Tajikistan, the relative price of the skilled-intensive
good will rise. In western Europe, this leads to an increase in the real earnings of
skilled labor and a decrease in the real wage of unskilled labor. The situation would
be opposite in the Tajikistan, where the real wage of unskilled labor would increase.

9. Following are data for soybean yield, production, and trade for 2010–2011:

Yield Production Export Import

(metric (100,000 (100,000 (100,000
ton/hectare) metric tons) metric tons) metric tons)

Australia 1.71 0.29 0.025 0.007

Brazil 3.12 748.2 258 1.18
Canada 2.75 42.5 27.8 2.42
China 1.89 144 1.64 570
France 2.95 1.23 0.24 5.42
Japan 1.60 2.19 0.0006 34.6
Mexico 1.32 2.05 0.001 37.7
Russian 1.48 17.6 0.008 10.7
Federation
United States 2.79 831 423 4.45

Data from: Food and Agriculture Organization.

 Suppose that the countries listed in the table are engaged in free trade and that
soybean production is land-intensive. Answer the following:

a. In which countries does land benefit from free trade in soybeans? Explain.
Answer: Landowners in the United States, Brazil, and Canada benefit from free
trade since the production of soybeans intensively uses land as a factor of
production, since these countries export more soybeans than they import.

b. In which countries does land lose from free trade in soybeans? Explain.
Answer: As net importers of soybeans, landowners in China, Mexico, Japan,
Russia, and France lose from free trade because the world-relative price of
soybeans is lower than each country’s no-trade equilibrium price.

c. In which countries does the move to free trade in soybeans have little or no effect
on the land rental? Explain.
Answer: The move to free trade in soybeans is likely to have little or no effect on
the land rental in Australia, since its import and export of the product is about
equal.

10. According to the Heckscher–Ohlin model, two countries can equalize wage
differences by either engaging in international trade in goods or allowing high-skilled
and low-skilled labor to freely move between the two countries. Discuss whether this
is true or false, and explain why.
Answer: Allowing skilled workers to migrate to skilled-labor-scarce countries and
unskilled workers to migrate to unskilled-labor-scarce countries reduces the ratio of
skilled/unskilled workers in the skilled-labor-abundant country and raises it in the
unskilled-labor-abundant country. This increases the wage ratio between skilled and
unskilled labor in the skilled-labor-abundant country and lowers it in the unskilled-
labor-abundant country.
When the two countries trade in goods that embody these factors, the skilled-labor-
abundant country will export the skilled-labor-intensive good. By doing so, it
effectively sends a lot of skilled workers and a few unskilled workers to the unskilled-
labor-abundant country. Likewise, when it imports the unskilled-labor-intensive
good, it effectively imports a few skilled workers and a lot of unskilled workers. The
net effect is skilled workers in the unskilled-labor-abundant country see a fall in their
wage relative to unskilled labor and unskilled workers experience a rise in their
relative wage, similar to that of migration.
When all the strict assumptions of the Heckscher–Ohlin model are satisfied, we can
get this factor price equalization theory: Trade leads to equalization of returns to
factors across countries. As product prices in two countries converge to the same
world price level, the difference in the factor prices narrows, and ultimately
disappears. But this theory should not be viewed as Holy Grail, as it requires
“extraordinarily demanding” assumptions that are not quite satisfied in the reality.

11. According to the standard Heckscher–Ohlin model with two factors (capital and
labor) and two goods, the movement of Turkish migrants to Germany would decrease
the amount of capital-intensive products produced in Germany. Discuss whether this
is true or false, and explain why.
Answer: An increase in a factor of production raises the production of the good that
uses that factor intensively and reduces the production of the other good. So as labor
flows from Turkey to Germany, labor endowment increases in Germany. The
production of labor-intensive goods relative to capital-intensive goods will increase in
Germany.